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Defense Contracting in Saudi Arabia

New Opportunities for Military Contractors under Vision 2030

New Opportunities for Military Contractors under Vision 2030

Amgad Husein, Anas Akel, John Balouziyeh

April 6, 2017

Saudi Arabia's Vision 2030 and the National Transformation Program 2020 present unprecedented opportunities to military contractors to invest in Saudi Arabia. In pioneering a new vision for a local military manufacturing sector, the Saudi government is seeking partnerships with leading security and defense companies. Vision 2030 offers these companies diverse opportunities for joint ventures, technology transfers, consulting and training.

Traditionally, opportunities for military contractors in Saudi Arabia have been limited to the sale of armaments and other military equipment to the government of Saudi Arabia and ancillary services relating to those sales, such as servicing military equipment, providing spare parts and training military personnel on the use of equipment, armaments and military vehicles. The sphere for military contractors has been further restricted through expansive regulations in the military sector, including regulations prohibiting military contractors from engaging agents on a commission basis in sales of armaments and military equipment to the Saudi Arabian government. Moreover, the Supreme Economic Council has maintained a ban on foreign investors from carrying out a wide range of activities within the military sector, including manufacturing military equipment, devices and uniforms.

These restrictions are about to undertake a shift with the introduction of Saudi Arabia's Vision 2030 and the National Transformation Program 2020, which seek to incubate for the first time an indigenous military manufacturing industry. While Vision 2030 may not lift the ban on foreign investment in the military manufacturing industry, it will without doubt bring other opportunities for partnership between the Saudi Arabian government and the world’s leading and most innovating military contractors.

Current Restrictions

A. Overview

One of the issues that defense companies often encounter is the restriction on foreign investment in the manufacture of military equipment and devices within the Saudi Arabian defense sector. Manufacturing of military equipment and devices has historically been included on the Negative list. Defense contractors have thus been limited in the range of activities they could undertake in Saudi Arabia. Even obtaining a license in the area of trade and distribution of armaments and military equipment is restricted in Saudi Arabia. Unlike in other sectors, where foreign companies could own shares in companies engaged in the import and sale of products imported to Saudi Arabia, in the military sector, it is the local client (normally the Saudi government) that handles the importation of products and the clearance of customs as part of the sale and purchase of armaments and other military equipment. The in-Kingdom commercial activities of defense contractors have thus been historically limited to the installation and maintenance of military equipment and technical support and training activities.

B. Negative List

The Supreme Economic Council has historically maintained a Negative list of sectors in which foreign investors could not carry out investment. Within the manufacturing sector, this has included a prohibition on manufacturing of military equipment, devices and uniforms as well as restrictions on manufacturing civilian explosives. Within the service sector, it has included a prohibition on catering to military sectors, security and detective services. Non-Saudi companies that are registered in GCC countries may in some cases obtain SAGIA licenses to undertake the above restricted activities, but non-Saudi companies having no presence or registration in the GCC companies, with rare exception, have historically been denied licenses to engage in the military-sector activities included on the Negative list.

Paradigm Shift under Vision 2030

A. Overview

Many of the restrictions in the military sector will undergo a shift as Saudi Arabia seeks to engender indigenous industries and accelerate its shift from oil dependence. Under Vision 2030, the Saudi government is targeting self-sufficient industries with an emphasis on the defense, healthcare and education sectors. The defense sector will lead to wide-ranging opportunities for foreign investors, given a growing threat to Saudi national security posed by ISIS across Saudi Arabia’s northern border in Iraq and the threat posed by Iran-backed Houthi rebels across the southern border in Yemen. In response, the Saudi government has appropriated more than USD 50 billion in defense spending in 2017 alone.

B. Local Manufacturing Goals under Vision 2030

Vision 2030, which includes ambitious plans to localize manufacturing in the Saudi Arabian defense sector, indicates a shift in these restrictions. Vision 2030 states, in part, as follows:

The benefits of localizing our own defense industries are not limited to solely reducing military spending. It also stimulates other industrial sectors such as industrial equipment, communications and information technology, which in turn creates more job opportunities. Although the Kingdom is the world’s third biggest military spender, only 2 percent of this spending is within our Kingdom. The national defense industrial sector is limited to only seven companies and two research centers.

Our aim is to localize over 50 percent of military equipment spending by 2030. We have already begun developing less complex industries such as those providing spare parts, armored vehicles and basic ammunition. We will expand this initiative to higher value and more complex equipment such as military aircraft. We will build an integrated national network of services and supporting industries that will improve our self-sufficiency and strengthen our defense exports, both regionally and internationally.

Localization will be achieved through direct investments and strategic partnerships with leading companies in this sector. These moves will transfer knowledge and technology, and build national expertise in the fields of manufacturing, maintenance, repair, research and development. We will also train our employees and establish more specialized and integrated industrial complexes.

Vision 2030 thus promises foreign defense firms unprecedented opportunity in the Saudi defense sector in establishing local military and defense capabilities, including building military aircraft. While there may not be a formal lift on restrictions on foreign ownership in local defense manufacturing, opportunities will abound for foreign companies committed to Saudi Arabia through joint ventures, technology transfers and local employment and training in support of Vision 2030’s stated goal of transferring “knowledge and technology, and [building] national expertise in the fields of manufacturing, maintenance, repair, research and development.”

These opportunities will spring from increased Saudi defense spending under Vision 2030. At least USD 50.9 billion has been appropriated in the 2017 Saudi fiscal year for military and security services. Saudi Arabia’s stated goal of shifting from 2 percent to 50 percent local military equipment manufacturing will depend on business deals with foreign defense firms whose focus is on higher-value equipment and innovative technology.

Foreign defense firms will thus find opportunities to procure contracts not only with branches of the Saudi Arabian armed forces, but also with entities such as the Military Industries Corporation (MIC), which will oversee major facets of the development of the Vision 2030 local defense industry.

Application of Vision 2030’s Local Manufacturing Goals: Current Local Manufacturing Requirements

Following the announcement of Vision 2030 on 25 April 2016, the Saudi government took steps to begin to implement the plan’s goals and vision. In its goal of localizing over 50 percent of military equipment spending, the Saudi government is initially focusing on the local manufacture of spare parts, equipment and fittings. With this in mind, the government has launched the General Department for Local Manufacturing Support (الإدارة العامة لدعم التصنيع المحلي), whose website (https://www.gdis.gov.sa/Portal), published in 2017, announces the Department’s goal of implementing the government’s manufacturing localization strategy by forging public-private partnerships between the Saudi armed forces and private sector actors and ensuring that locally-manufacturing parts meet the same standards, specifications and quality as those that had formerly been manufactured abroad.

Steps to localize defense manufacturing can be seen in the realm of supply contracts between the Ministry of Defense and Aviation (MoDA) and defense contractors. Today, less than a year after the formal launch of Vision 2030, MoDA is requiring defense contractors to provide for the local manufacture of certain elements the objects of supply contracts. This means defense contractors and suppliers may be required to visit Saudi Arabia to identify partners that can manufacture spare parts and other elements of supply contracts that meet MoDA standards and specifications. In coordination with the General Department for Local Manufacturing Support, defense contractors and suppliers, together with the Saudi government beneficiary entity, may further be required to prepare and define a program for achieving local spare parts manufacturing. In such cases, the locally-manufactured products must be delivered in accordance with the defined program before the expiration of the contract term. Defense contractors may additionally be required to participate with the General Department for Local Manufacturing Support in the prequalifying process of national companies that will be engaged in local manufacturing in accordance with the approved local manufacturing standards. If a local manufacturing requirement is imposed, defense contractors must produce a Certificate of Local Manufacturing countersigned by the General Department for Local Manufacturing Support and submit it along with their supply contract before they can receive full payment from MoDA.

In cases in which suppliers are required to undertake a local manufacturing obligation, the initial percentage of local manufacture may be low. For example, MoDA may impose a requirement that 5 to 15 percent of spare parts be locally manufactured. However, as we approach the 2030 target for 50 percent of local manufacturing, these thresholds are likely to increase. It is likely that the Saudi government will implement a tiered approach, with supply contractors being initially required to manufacture spare parts in-Kingdom and later transition to producing ammunitions and small arms before transitioning to more sophisticated weapons systems, which may take decades to develop. In all cases, MoDA will likely require that defense contractors and suppliers certify that local manufacturing quotas have been met as a precondition to the receipt of the full payment of underlying supply contracts.

Conclusion

In incubating a local defense manufacturing industry, defense contractors have an unprecedented opportunity to partner with the Saudi government and local partners in transferring know-how and expertise. Prior to submitting an application for licensing to the Saudi Arabian General Investment Authority, defense contractors would do well to arrange meetings with officers from the MoDA or of the various branches of the Saudi Arabian Armed Forces to explain what their companies can bring to the table, how their military equipment and technology can play a role in strengthening Saudi Arabian security and why MoDA should stand behind their applications for licensing and ensure that their licenses include the broadest range of licensed activities possible. In this way, defense contractors will act as key partners in strengthening the security of Saudi Arabia, a bedrock of stability in the Middle East.

Author Biographies

Amgad Husein

Having practised in the Middle East since 1999 and in Riyadh since 2001, Amgad's work focuses primarily on major American, European and Asian banking and industrial and corporate institutions doing business in the Kingdom of Saudi Arabia. Chambers Global notes that clients praise the Riyadh group's "helpfulness, efficiency and in-depth knowledge of local and international law" and that Amgad Husein "consistently impresses with his advice and assistance." Clients are full of praise for Amgad Husein, with one saying: "much of the value comes from Amgad. He rolls up his sleeves and gives good, helpful advice. He is dedicated and always on call." Amgad is recommended for his “practical approach and very good understanding of the Saudi commercial and governmental environment.”

Anas advises companies and foreign investors in setting up and operating in Saudi Arabia and has handled a wide array of corporate, commercial and cross-border transactions and disputes in the United States, Latin America, Asia, and the Middle East. His background includes representation on regulatory compliance, insurance, banking and capital markets matters. Prior to joining the firm, Anas was the General Counsel and Corporate Secretary of AlAhli Takaful Company (ATC), a publicly listed insurance company in the Kingdom of Saudi Arabia, where he was responsible for legal, compliance and regulatory matters. Anas is fluent in Arabic and English and proficient in Spanish.

John advises multinational public and private companies on investing in Saudi Arabia through joint ventures, cross-border mergers and acquisitions and public-private partnerships. He also serves as a Judge Advocate in the U.S. Army Reserve JAG Corps. Prior to joining Dentons, John worked at the US Department of State in state-investor arbitration and rotated through the US Embassies in Damascus and Abu Dhabi. John has clerked at various international courts, including the Inter-American Court of Human Rights. A common law and civil law qualified attorney, he has authored and edited various books and articles dealing with international and comparative law. John reads, writes and speaks Arabic, French, Spanish and Turkish.

About MEPC

The Middle East Policy Council is a nonprofit organization whose mission is to contribute to American understanding of the political, economic and cultural issues that affect U.S. interests in the Middle East.